Congress has passed tax reform and President Trump has signed the bill into law. Consequently, the tax code will be dramatically changed for many. Although there are many uncertainties in how the implementing regulations and rules will look, many businesses and certain industries will significantly benefit. There will be ample tax planning opportunities, and we have provided the major highlights to get you started.
Specifically, we have organized the highlights into four groups. The first is for real estate businesses and is applicable to businesses generally. This section talks about the 20% deduction for pass-through businesses like partnership and S-corporations. The second group is geared toward all employers and contains a significant tax credit for paying employees on FMLA. The third group provides the relevant provisions applicable to tax-exempt organizations such as an excise tax to the entity on excessive compensation. Lastly, there is something for everyone as we pulled out highlights pertaining to almost all of us individually.
Business / Real Estate
Corporate Tax Rates Reduced:
The corporate tax rates have been permanently reduced to a flat 21%.
Deduction for Pass-Through Income:
A new section, Code Sec. 199A, “Qualified Business Income,” will enable a non-corporate taxpayer who has qualified business income (QBI) from a partnership, S corporation, or sole proprietorship to take a deduction of 20% of the QBI. There is a cap on the deduction amount, but the provision generally favors certain non-corporate entities owning commercial real estate because there is a more generous cap on the deduction for such entities.
Net Interest Expense Deduction Limitation:
Businesses with high interest expense deductions that generally have over $25 million in gross receipts may not be able to deduct all of such interest expense. The disallowance of a deduction for net interest expense kicks in when the expense is over 30% of the business’s adjusted taxable income. Real property trades or businesses can elect out if they use the Alternative Depreciation System to depreciate the applicable real property.
Carried interest has been a hot topic and the new law slightly modifies the current rules. The new law imposes a three-year holding period requirement in order for certain partnership interests received in connection with the performance of services to be taxed as long-term capital gain. If the three-year holding period is not met, the taxpayer’s gain will be treated as short-term gain and taxed at ordinary income rates.
Like-Kind Exchange Treatment Limited to Real Estate:
Deferral of tax through like-kind exchanges continues to be available for real property not held primarily for sale. However, going forward in 2018, like-kind exchange treatment will not be available for personal property.
Recovery Period for Qualified Real Property Shortened:
Qualified improvement property placed in service after December 31, 2017, is depreciable over 15 years using the straight-line method. Qualified improvement property is any improvement to an interior portion of a building that is nonresidential real property if such improvement is placed in service after the date the building was first placed in service. Qualified improvement property does not include any improvement for which the expenditure is attributable to the enlargement of the building, any elevator or escalator, or the internal structural framework of the building.
Rehabilitation Credit Changes:
Unfortunately, the 10% credit for qualified rehabilitation expenditures (QRE) of certain older buildings has been eliminated. Further, the 20% credit for QRE of certified historic buildings will now not be available in the year the building is placed in service. Rather, the credit will have to be taken ratably over 5 years. This will severely impact the market for tax equity investing.
Specific to Employers
New Credit for Employer-Paid Family and Medical Leave:
For the next two years, businesses can receive a credit on taxes for wages paid to qualified employees during the time the employees are on family and medical leave under the Family Medical Leave Act (FMLA). The credit is up to 25% of the wages paid.
Employer’s Deduction for Fringe Benefit Expenses Limited:
The deduction for entertainment expenses will now be eliminated as will the deduction for employee transportation fringe benefits. Further, there is now a 50% limitation on the deduction for meals provided through an in-house cafeteria or otherwise on the premises of the employer.
Deductions For Sexual Harassment Expenses Eliminated:
Any settlement payments for sexual harassment or sexual abuse allegations may not be deducted under the new law if the payments are connected to a nondisclosure agreement.
Excise Tax on Excess Tax-Exempt Organization Executive Compensation:
Now, a tax-exempt organization is subject to a tax at the new corporate tax rate (21%) on certain excess compensation to covered employees.
Excise Tax on Investment Income of Certain Colleges and Universities:
There will be an excise tax of 1.4% on net investment income of certain private colleges and universities.
Unrelated Business Taxable Income Separately Computed for Each Trade or Business Activity:
Tax-exempt organizations that run multiple unrelated trades or businesses may no longer use losses from one to offset income of another.
Individuals / Estate Planning
Increased Exemption Amount for Estates
The exemption amount has been increased from $5 million to $10 million with the higher amount indexed for inflation starting in 2011. The exemption for a married couple in 2018 is estimated to be $22.4 million. Further, although not clear from the new law, the changes are expected to impact the generation-skipping transfer exemption.
Home Mortgage Interest Deduction Limited Temporarily:
The deduction for interest on home equity indebtedness is suspended and the deductions on mortgage interest is limited to the first $750,000, instead of $1 million, of the mortgage.
Alimony and Separate Maintenance Payments No Longer Deductible:
For divorces or separation agreements executed in 2019, there will be no deduction for alimony or separate maintenance payments and no income for receiving these payments.
The highlights above are short descriptions to provide a survey of the new changes. Please contact Vikram Agarwal with Bean Kinney and Korman if you are interested in tax advice for a more in-depth understanding of how there may be planning opportunities specific to your circumstances.